Small business Law Articles

What do I need to do when I contribute financing to my small business?

Even when a small business owner is providing self-financing for the small business, there are certain rules that should be followed.

byon Jun 19, 2009

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Even when a small business owner is providing self-financing for the small business, there are certain rules that should be followed.

When a small business owner provides funding for her small business, there are a few important things to keep in mind.

Important Tip Even though it is much easier when a small business owner provides her own funds, there are still important guidelines to follow.

Segregate Funds. It is important to segregate the funds of the small business from the personal funds of the small business owner. Do not run the small business finances out of the bank accounts of the owner. This could be a factor in making the small business owner liable for the debts of the small business.

Keep Careful Records. It is important to keep careful records of the amount of money provided by a small business owner to a small business. There are potential tax advantages to money provided for a small business that may offset personal income tax liability – for example, it can determine the basis for the stock and result in lower tax payments when the stock is sold. In addition, when a small business has various investors – whether stockholders or lenders, it is important to keep careful track of the money provided by the owners as it can affect the percentages of stock ownership or the priority under which distributions from the small business will be made. Finally, when attracting other investors, it is good to have a record of how much funding has been provided by the owner.

Financing in the form of Capital Contributions. Most funding provided by an owner to a small business will be in the form of capital contributions. These should be reflected on the books of the small business corporation or the limited liability company to proper reflect the amount of the contribution and the person providing it. In the case of a small business established as corporation with a sole stockholder, it is not necessary to issue additional stock as additional capital contributions are made (the owner will own 100% of the corporation both before and after the additional contribution). It is important to keep track of the total amount of the contributions for the time when the stockholder sells her stock or brings in additional stockholders. Where there are multiple stockholders, it is important to issue new shares to make sure the stockholding percentages reflect the new capital contribution. In addition, in Colorado, you should consult the articles of incorporation of the corporation to determine if there are preemptive rights, which would give other stockholders the right to purchase a proportionate amount of shares on the same terms. In the case of limited liability companies with one or more members, it is important to reflect capital contributions on the capital accounts of the member or members providing the contribution. Also, the Operating Agreement should be reviewed to make sure the capital contributions are being handled in accordance with its provisions.

Financing in the form of a Loan. A small business owner might also want to reflect funding as a loan to the small business in some cases. A loan would create an obligation of the small business and could have priority over certain other types of funding. Typically, a loan would have an interest rate (or, the Internal Revenue Service might impute one). The interest would create taxable income to the business owner and a deduction for the small business. Any loan should be reflected by a promissory note. If a small business later seeks bank financing, a bank might require personal loans to be subordinated to the bank loan.

Related Party Transactions. In the case of funding (whether by loan or by capital contribution) by a small business owner to a small business, the related party transaction provisions of the Articles of Incorporation or Bylaws, in the case of a corporation, or the Operating Agreement, in the case of a limited liability company, should always be checked. The relevant State laws should also be checked to make sure the transaction does not violate any of those provisions. Often, there are requirements that related party transactions be approved by directors or stockholders that are not interested in the transaction. So, if one stockholder is loaning $50,000 to a small business, the other stockholders might have to approve the terms of the loan.

Additional Information

Important Tip:

Even though it is much easier when a small business owner provides her own funds, there are still important guidelines to follow.

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